HKEX hoped alchemy would turn acquisition of century-old London Metal Exchange into ‘super-connector’ gold. What went wrong?

After March’s trading suspension, HKEX has started an internal review at LME. Separate reviews by the Financial Conduct Authority and the Bank of England have also been initiated
HKEX’s Nicolas Aguzin remains optimistic about LME and says the bourse remains ‘well positioned’ to benefit from its links with China

Hong Kong at 25

Georgina Lee

Published: 11:00am, 14 Jun, 2022

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When Hong Kong Exchanges and Clearing (HKEX) acquired the 145-year-old London Metal Exchange (LME) in 2012, it was hoped that the Hong Kong bourse operator would extend its role as a “super-connector” and link China’s commodity markets with the world through the UK-based exchange.

Tens years later – as the London bourse embarks on a reputation rebuilding exercise after having to cancel trading for only the second time in its history in March – some are asking whether the £1.39 billion (US$1.7 billion) acquisition engineered by former HKEX chief executive Charles Li Xiaojia has achieved its intended purpose. The cancellation followed a surge in nickel prices that threatened to destabilise the market amid a short squeeze that triggered billions of dollars in margin calls.

The fiasco was triggered amid heightened geopolitical tensions and global inflationary pressures, as Russia’s invasion of Ukraine sparked global supply concerns and sent the price of nickel soaring.

In its aftermath, HKEX started an internal review at LME. Separate reviews by the Financial Conduct Authority and the Bank of England were also initiated.

Exchange Square, which houses the Hong Kong stock exchange, in the city’s Central district. HKEX’s acquisition of LME was intended to boost commodities trading in Hong Kong as part of China’s 12th five-year plan. Photo: AP

The acquisition of LME was intended to boost commodities trading in Hong Kong as part of China’s 12th five-year plan. Li also made it clear that the deal represented a major step towards diversifying the bourse’s business away from equities and HKEX becoming a “international bourse operator”.

“Unlike equities, where there are fewer concerns when corporate issuers choose to diversify their listing venues outside their home markets, commodities are often closely associated with a government’s strategic resources,” said Bruce Pang, head of macro and strategy research at investment bank China Renaissance.

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“Given that LME is a global pricing hub for metals, it would be more challenging for HKEX to serve various stakeholders through LME without first tackling scrutiny arising from various geopolitical interests,” he added.

A decade since the deal was concluded, Hong Kong’s success as a super-connector to China appears to not have extended to commodities, in contrast with the Hong Kong stock exchange’s triumph in equities, where it has been the top market globally for initial public offerings (IPOs) in seven out of the previous 13 years. The city is also a pre-eminent market for Chinese issuers raising funds through IPOs, as well as for mainland Chinese investors trading shares of Chinese companies not listed at home.

Nicolas Aguzin, HKEX’s current CEO, continues to be optimistic. “A big proportion of the world’s commodities is produced in China. More importantly a lot of commodities are consumed in China,” he said during a media briefing after its first-quarter results were announced late last month. “So there is a lot of room for LME to continue to benefit from that long-term trend. We are well positioned.”

Nicolas Aguzin, HKEX’s current CEO. Photo: Handout

Because of China’s capital controls, LME has not been able to expand its network of more than 500 authorised warehouses in the country. Without more onshore warehouses, LME’s settlement prices for any of its zinc, copper, aluminium and nickel contracts would be irrelevant for traders in China, the world’s top producer of non-ferrous metals at 64.5 million tons in 2021, observers said.

HKEX has since 2019 launched six base metals mini futures contracts denominated in US dollars that reference LME prices, and the contracts are settled in Hong Kong. These are “mini” as each comprises 5 tons of metals, rather than the 25 tons per contract traded on LME.

But these mini contracts have not drawn in much liquidity. For the first quarter of 2022, these six products traded 90,289 lots, doubling from the same quarter a year ago, but were still far short of the 89.1 million lots traded by the Shanghai Futures Exchange. Trading fees from the exchange contributed HK$280 million to HKEX’s total revenue of HK$4.7 billion (US$598.8 million).

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LME also faces competition in China from the country’s own commodities futures exchanges, which are also slowly opening up to foreign investors. The Shanghai International Energy Exchange, a subsidiary of the Shanghai Futures exchange, for instance, already allows foreign investors with an initial margin of not less than 100,000 yuan (US$15,132) or equivalent foreign currency to trade bonded copper futures, crude oil, iron ore, technically specified rubber 20 and low-sulphur fuel oil futures contracts.

Changes might be afoot in Guangdong, where HKEX-owned Qianhai Mercantile Exchange has since October 2018 been offering spot commodities trading. The Hong Kong exchange operator wants to establish yuan spot price benchmarks for various metals as a start, and will establish a mutually recognised warehouse warrant system between LME and Qianhai Mercantile Exchange.

This could form the basis of a “commodity connect”, linking China’s vast commodity markets with LME, HKEX has said.

LME’s nickel rout: does the 145-year metals exchange have a future?

Despite the challenges of overseas expansion, LME is expected to continue enjoying its status as the reference for global metal pricing, industry players said, even as mainland Chinese exchanges are attracting more trading volumes.

“With over a hundred years of history, LME has always been the benchmark for physical transactions,” said Arthur Fan, head of Asia-Pacific at commodity-focused financial services firm Marex.

“Its settlement prices are hard-wired into many physical trade contracts and this makes it hard to be replaced.”

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